This blog is a collection on my ramblings on Economics. I plan to write on current economic issues, recent research (sometimes mine, but more often others’), and issues of interest to economists. As I am writing from Turkey, I will try to focus more on the Turkish economy. While I will write in English, I will refer to articles in Turkish and might occasionally invite a guest blogger to write in Turkish. So, apologies for the semi-bilingual nature of the blog if you do not speak Turkish...

Wednesday, March 24, 2010

I have got quite a few questions on the fiscal rule. I guess people feel that with the IMF gone, it really becomes mostly fiscal, especially with elections approaching, and the fiscal rule is a big part of the fiscal picture. Anyway, with questions pouring in, I decided to devote a blog post to the issue rather than copy and paste the same email:)

Loyal readers would note that I have written several times on the fiscal rule, so I will just summarize my views here. But just to put things into perspective, I first wrote about the fiscal rule when it appeared in the Medium-Term Economic Program in September. I returned to the issue in January when Economics Minister Babacan brought the issue up with its regular dinner discussion with esteemed Economics columnists- being an eagle-tattooed Besiktas fan, your friendly neighborhood economist does not aspire to being an esteemed economist, anyway. Finally, my love for the fiscal rule was so great that I could not help but mention it on Valentine's day, during my discussion of the 2010 budget projections.

I doubt the fiscal rule, in the current set-up, would be the appropriate rule for Turkey, for a number of reasons: First, for a country like Turkey, the composition of the budget is at least as important as the actual budget. In other words, numerical policy rules do not make sense for a country with a sketchy fiscal track record if they are not accompanied by procedural rules such as a cap on non-interest expenditures. Second, the rule seems to be on the central government budget. I am not sure leaving local governments (municipalities) out makes sense for Turkey, unless you are planning to run pre-election pork-and-barrel spending.

Going into the details, I was almost tricked into thinking that the actual formula was conservative enough for Turkey, but an email exchange with a loyal and knowledgeable reader and some growth forecasting convinced me otherwise. The target growth rate of 5%, unless the coefficient associated with it is very small, is bound to end up in a too-loose fiscal policy, which is not exactly the point of the fiscal rule.

Even if the government manages to come up with the right rule for Turkey, implementation will be a huge challenge. Unless the rule is hammered into the constitution, there will always be the risk that it will share the destiny of the ill-fated borrowing limits in the fiscal control law, being cropped or even nullified with subsequent laws.

In fact, fiscal rule per se does not even ensure fiscal credibility. A useful analogy is with inflation targeting: Having inflation targeting per se or even attaining the inflation targets does not make a central bank credible; it is the institutions that come along that do. Similarly, without an independent and authoritative budget monitor or fiscal council, it wouldn’t be a big surprise if the Turkish fiscal rule, even after being ironclad in the constitution, would not gain much ground.

Another key issue is monitoring: Fiscal policy experts have repeatedly been pointing at lack of full transparency and shenanigans in public accounts, which do not bode well for the implementation of a fiscal rule. I know one institution that recently stopped doing its highly-regarded fiscal monitor, precisely because they had no idea what was going on.

I would like to keep my hopes up, but I am still convinced that with the IMF gone, the fiscal rule will be the government's new opium to the masses. That's why I am awfully worried about the withdrawal to come.

2 comments:

Dear Sir, I am firmly concinced that a fiscal rule can be a very effective tool for fiscal discipline. As you mention in your note, the institutional setup is key to its success. Switzerland had a constitutional (!) borrowing constrained that was never applied. A better designed new fiscal rule changed everything, however. What changed was a binding annual ceiling for (cyclically adjusted) spending (based on cyclically adjusted revenue). There was not the possibility anymore of temporising. The rule also has a defined sanction mechanism which quickly enforces sanctions if deviations occur. A Swiss type rule (with some modificatins) might be successful in Turkey too.Kind Regardsage

Thanks for your comments, through which (and some quick reading this morning), I was able to learn about Switzerland's fiscal rule. As I noted in a recent blog post (http://emredeliveli.blogspot.com/2010/05/yet-more-on-fiscal-rule.html), the main tenets of the Swiss rule are surprisingly a good fir for Turkey.

Let's see if the government will deliver its promise to get the fiscal rule going next month. I doubt it, but the current government has been able to surprise me both positively and negatively many times...